Advantages and Disadvantages of Fixed, Life Annuities for Retirement

A fixed, life annuity will pay you a fixed income for as long as you live. This is a very attractive feature of a retirement investment to which many soon-to-be retirees give serious consideration. But all investments have both good and bad points, and fixed annuities are no exception. Here , I overview some of a fixed life annuity's advantages and disadvantages.

*Advantages of fixed, life annuities:

As mentioned above, the main benefit is that a life annuity offers you a monthly income for as long as you live - for a given amount of money. You may contribute that money all at once in a lump sum or you may have contributed it over the years in a series of payments.

Three important features of an annuity are tax-deferred accumulation, safety, and guaranteed life income. The tax-deferred accumulation - in comparison to a similar taxable investment - allows for greater accumulation since earnings are not taxed away annually. The tax-deferred accumulation is for all you contribute to the annuity before you 'annuitize' it to begin the annuity payments to you.

Annuities have been very safe vehicles in which to invest. Only very rarely have defaults occurred. There are state guarantees and company procedures that help assure your annuity investment. Nevertheless, you should always check out the strength of any insurance company you're considering buying from.

With the guaranteed life income payout option, you don't have to worry about market downturns that could rob you of income - a common feature of so many other investments.

Also if you can put off your payout until you're older, you're annuitized monthly payout will increase not only from increased accumulations of your earnings but your reduced life expectancy. That's because the shorter is your statistical remaining life expectancy, the more the insurance company will pay you per month.

*Disadvantages:

Because an annuity is a long-term investment with tax-deferred status, the IRA imposes a 10% excise tax penalty on any withdrawal before age 59 1/2. That's in addition to any income tax you pay on those withdrawals.

Insurance companies typically impose annuity fees on withdrawals you make early in the accumulation years. These can significantly cut into those withdrawals. So if you're contributing to an annuity over many years, plan on holding off for 10 years or so to let your earnings offset this effect and for those fees to expire.

Since your money is placed with an insurance company in an annuity contract, you have little control over the rate of return on your investment. A good company will pay a return competitive with that credited on 52-week Treasury bills, and maybe slightly higher.

Although with a fixed annuity you've eliminated the possibility of market risk on your investment, you have created the risk of losing purchasing power. The fixed annuity means that your monthly payout when annuitized remains a constant (fixed) dollar amount. Inflation is always present, though. It will reduce the purchasing power of that monthly payout. Over a long term payout time, inflation can seriously erode that purchasing power.

Lastly, when you choose a lifetime income for your annuity payout, the contract generally leaves no residual money for your heirs when you do die - no matter how soon you die after beginning your annuity payments. That's the other side of the gamble on a lifetime payout.

Nevertheless, you can choose options that can remedy this downside to some extent. But those options come at the cost of lower monthly payouts.


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Shane Flait helps you with your financial legal, tax, and retirement goals.
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